It’s a known fact that novice investors frequently lose their way due to volatility while trading markets that exchange asset classes such as stocks, commodities, bonds, or even crypto assets. Even the most experienced investors can be confused by price reversals, despite the fact that long-term investing is typically advised to survive these periods of volatility.
To avoid becoming a victim of market influenced trends, it’s crucial to recognise the signs and symptoms of a phoney reversal, or a temporary change in charge direction, before the underlying trend restarts. Let’s discuss this further.
The Pain of Falling Into a Bear Trap
Increased volatility may even attract short-term investors to place many investments in an attempt to time the markets, which may result in significant losses and harm their confidence or concept of the underlying asset.
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A sudden downward charge motion can cause increased volatility in an uptrending market, driving participants to liquidate long positions or short the underlying asset in an effort to make a quick buck. Even when a number of traders sell in bulk, this reversal may only last for a short period of time, allowing the traders to buy back their holdings at a lower price.
This type of market manipulation, known as an undergo entice, tricks bearish people into thinking that the price reversal signals the start of a decline and is frequently accompanied by a strong continuation of the prior upswing. Shorting, the practice of selling an asset only to buy it back later at a lower price, is particularly speculative in these times of volatility and causes investors to take on unnecessary risk.
Even long-term investors may fall to temporary boosting stress and lose all or part of their yields because an undergo entice is frequently unexpected and short-lived.
What Every Investor Needs to Know About a Bear Trap
A bear trap is a short-lived price reversal that incorrectly signals the beginning of a downtrend. The crowdsale of a certain coin works in concert with one another to lower its price and persuade other retail investors that the rise is gone. As a result, the price continues to decline for a few hours or days. This enables numerous investors to sell their holdings.
A powerful bullish rise that traps a large number of negative bets usually results from these influential traders buying back the quantities sold at reduced rates when prices break below previously held lows. Traders with short positions would rush to buy the crypto asset in an effort to reduce their losses, but this purchasing urge just serves to raise the price even higher.
A group of bear-trap traders or developers aims to gain profits from the difference in price without affecting the quantity of crypto they hold over a long period. They do this by selling at higher prices, then buying back all their positions when prices drop.
Popular cryptos like Bitcoin (BTC) can be shorted on the base crypto asset utilising a variety of techniques like token shorting, margin trading, or futures and options trading, just like other asset classes like actively traded stocks can. Experienced traders and institutional investors frequently use these channels to hedge their holdings in the secondary market and can safeguard their assets should the market or trend reverse.
As a result, shorting a crypto asset, or shorting it through any of the available methods, is a frequent practice, though it only occurs in quantities that are small compared to the amount of primary token trade. However, when shorting a crypto like BTC on an extremely big scale, it can greatly pressure prices downward because of a jump in the general fear quotient.
Developing Your Trading Strategy With the Help of Technical Indicators
Technical indicators like the Relative Strength Index (RSI) may indicate that a crypto asset is moving into bearish territory, which may lead to a larger sell-off led by less experienced retail investors who are attempting to reduce their risk exposure.
More bearish investors may be tempted to go short if this mood persists and prices fall below important support levels, providing large traders with a lucrative opportunity to set off a bear trap by hedging their short bets.
The Motive of a Bear Trap in the Crypto Market
A bear trap begins when a group of investors with substantial token holdings short sells a crypto asset, and it ends when they close their derivative bets, reverse their short crypto positions, or a combination of both. Although anyone can start a short position or sell a crypto short, it is illegal to conspire with other traders to influence an asset’s price in markets like the United States, which could anger various central authorities.
In the strictest sense, a bear trap causes confusion among traders and market participants because it suggests that the underlying asset will experience a momentum shift that runs counter to the primary uptrend before abruptly reversing to resume its ascent. A bullish trader may view it as a buy signal if the asset’s price maintains its upward movement over the recent resistance level.
How to Avoid Bear Traps and Maximise Your Return on Investment
As an alternative, investors who adopt a bullish posture can use a method that involves concurrently selling calls and puts at critical price levels to realise profits over a wide range of prices. The first trend reversal might be taken as a sell signal for a bearish trader, which calls for careful risk-reward analysis and extreme prudence to prevent financial losses.
Trading a bear trap is highly challenging for a bearish trader because the entry point for entering a short position must be exactly timed. When shorted or leveraged, any error in identifying the start of the underlying uptrend can be fatal for bear holdings.
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Most often, identifying a persisting lure requires the use of technical analysis tools like RSI, Fibonacci levels, and quantity signs. These tools are likely to confirm whether or not the trend reversal is appropriate or not following a period of steady upward movement. He should have asked for the shorts, in fact.
To eliminate the possibility of a persistent lure, any decline needs to be pushed by utilising high buying and selling volumes. A trend is typically indicated by a combination of variables, such as price pulling back just below a crucial support level, failure to close beneath critical Fibonacci levels, and coffee quantity.
It’s best for crypto traders with modest risk appetites to avoid buying and selling during sudden and unjustified price reversals until price and volume actions confirm a trend reversal below a critical support level. During those times, it makes sense to hold onto your crypto assets and wait to sell them until prices have breached the original bid price or stop-loss level.
Understanding how cryptos and the crypto market as a whole respond to news, mood, or perhaps crowd psychology, is important. Doing this will be much harder than it sounds, especially when you consider the extreme volatility associated with the majority of crypto trading today.
Conclusion: Stay invested wisely
Buying a put option is more preferable to fast or becoming a prolonged seller at the underlying crypto assets if you want to profit from the momentum reversal. This is because a fast function no longer exposes the trader to unlimited risk if the crypto asset continues its uptrend, unlike shorting or selling a name alternative.
The latter technique limits losses to the top class paid and separates them from previously held long-term crypto investments. It’s best to stay away from trading during a persistent lure for long-term investors looking for income without taking on too many risks.
